Question

On December 15th, 2017, Star Inc. decided to put a piece of equipment that has a net book value of $430,000 on sale. One of the company’s shareholders showed interest in buying it for $400,000 and said that he was knowledgeable about the asset, which he intends to use in another business that he has. If Star Inc. accepts to sell the piece of equipment to the shareholder before its fiscal year end on December 31st, would you consider that as an orderly transaction and the price offered as the asset’s fair value? Explain.

Answer 1

Orderly transaction is not an forced transaction i.e there is sufficient market exposure that would allow the market participants to gain sufficient knowledge about the asset or liability.

Fair Value is the estimated price at which an asset can be sold or a liability could be settled in an orderly transaction to a third party under current market condition . Fair value measures assumes the highest and best use of asset by market participants.

Fair value is ideally determined based on price in active market. Fair value is determined either as per Market approach, income approach or cost approach.

Referring the question above,

The transaction is considered to be orderly since the transaction to sell the asset was not forced on the company or the sale was not an distressed sale or sale of assets under liquidation.

The concept of Fair value measurement assumes the transaction to be orderly between market participants, however in this case the price offered is not fair value as the fair value needs to be determined based on either

Market approach: Price of similar euipment

Income approach: estimate the price based on future cash flow discounted at a rate considering the risk and time value.

Cost approach: Estimated cost to replace an asset adjusted for obsolesence.

The price offered by the Shareholder is lower than the net book value of the asset, thus if the price is similar to fair value price determined as per above then only the price can be considered as fair value or else the price offered is not the Fair Value price.